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What is the monetary standard, or, how did the Volcker-Greenspan FOMCs tame inflation?

  • Robert L. Hetzel
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    A consensus now exists that central banks, which possess a monopoly over the creation of fiat money (the monetary base), control trend inflation. But how do they exercise this control, especially given that their use of the interest rate as the policy instrument renders money endogenous (determined by market forces)? This paper considers two alternatives. First, central banks control inflation through the way that they manipulate the unemployment rate (subject to a trade-off between changes in inflation and the amount of excess unemployment as summarized in a Phillips curve). Second, and alternatively, central banks control inflation by following consistent procedures that combine two characteristics. Through their consistency, these procedures provide for a nominal anchor by causing the public to expect low trend inflation that is stable in the sense of being unaffected by inflation and recession shocks. Also, they allow the price system to work in the sense of allowing market forces to determine real variables such as the unemployment rate.

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    File URL: http://www.richmondfed.org/publications/research/economic_quarterly/2008/spring/pdf/hetzel.pdf
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    Article provided by Federal Reserve Bank of Richmond in its journal Economic Quarterly.

    Volume (Year): (2008)
    Issue (Month): Spr ()
    Pages: 147-171

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    Handle: RePEc:fip:fedreq:y:2008:i:spr:p:147-171:n:v.94no.2
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    1. Orphanides, Athanasios, 1999. "The Quest for Prosperity Without Inflation," Working Paper Series 93, Sveriges Riksbank (Central Bank of Sweden).
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    4. repec:cup:cbooks:9780521881326 is not listed on IDEAS
    5. Goodfriend, Marvin, 2002. "Monetary Policy in the New Neoclassical Synthesis: A Primer," International Finance, Wiley Blackwell, vol. 5(2), pages 165-91, Summer.
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    21. Lucas, Robert E, Jr, 1996. "Nobel Lecture: Monetary Neutrality," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 661-82, August.
    22. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    23. Hetzel, Robert L & Mehra, Yash P, 1989. "The Behavior of Money Demand in the 1980s," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 21(4), pages 455-63, November.
    24. Nelson, Edward, 2001. "What Does the UK's Monetary Policy and Inflation Experience Tell Us About the Transmission Mechanism?," CEPR Discussion Papers 3047, C.E.P.R. Discussion Papers.
    25. Robert L. Hetzel, 1999. "Japanese monetary policy: a quantity theory perspective," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-26.
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